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Loss Exposure Trends Asset Managers and Funds Professional & Management Liability

Wendy Dowd, CFA Global Underwriting Manager, Asset Management Sector Chubb Specialty Insurance March 2014

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The Concern • The financial crisis had a severe and prolonged

effect on losses (years 2008-2010). • While post-financial crisis losses (2011 to present)

are down from the peaks of the financial crisis years, recent losses are developing materially higher compared to pre-financial crisis (2004-2007).

• Post-financial losses are experiencing both higher frequency and severity than pre-financial crisis losses.

Is this the “new normal”?

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The Concern

2004 - 2007

Lower loss period. No specific claim drivers. Losses from mix of operational, regulatory, investor, fees, and cost of corrections.

2008-2010 2011-2014

Pre-Crisis Financial Crisis Post-Crisis

Overall losses spike driven by frequency and severity. Investor claims Disclosure based claims Third Party Fraud Insider Trading Madoff Related Claims Bond fund prospectus

Accident Year

Market Timing

Industry systemic issue. Loss severity driven by defense costs for class action claims related to market timing and late trading, and subsequent excessive fee claims.

2003

Frequency of regulatory claims dominate losses, rounded out by investor claims and operational risk related claims, and the continuance of fraud related claims.

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Key Drivers Several key factors are driving post-financial crisis losses and expected to influence loss activity in 2014 and beyond: • Increased regulatory scrutiny • Frequency and breadth of systemic events • Increased demands and expectations from investors • Claims caused by third party exposures • Operational Risk • Increased loss costs

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The Regulatory Problem SEC Charges Multiple Hedge Fund Managers

with Fraud in Inquiry Targeting Suspicious Investment Returns

SEC Charges Money Manager and Firm for Misleading

Advertisements Department of Labor Continues Focus on

Fiduciary Responsibilities

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The Elephant in the Room

The single greatest factor driving losses post financial crisis is the frequency and severity of regulatory claims.

Regulatory Claims

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The SEC’s Aggressive Agenda • A Strong Pipeline – The Enforcement Division

headed into the next fiscal year well positioned for significant achievements across its program, having opened 908 investigations last year (up 13 percent) and obtained 574 formal orders of investigation (up 20 percent). SEC Announces Enforcement Statistics, Press Release Dec 17, 2013

• A Popular Target. Cases involving investment advisers, investment companies, and brokers represented 47% of the docket in 2013 compared to 28% in 2007. SEC Fiscal Year 2013 Agency Financial Report www.sec.gov/about/secpar/secafr2013.pdf

• Increased Activity. The number of SEC enforcement actions against investment advisers and investment companies in years 2010-2013, was more than 72% higher than the preceding four years 2006-2009. SEC Fiscal Year 2013 Agency Financial Report www.sec.gov/about/secpar/secafr2013.pdf

Formal Orders of Investigation

Up 20%

Investigations Opened Up 13%

2007-2009 2010-2013

66% More Adviser/Fund Enforcement Actions

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“No signs of abating”

“The large number of enforcement actions brought against investment advisers and brokers shows no signs of abating. To the contrary, as the SEC’s examination program extends its review of hedge funds and private equity funds newly-registered under Dodd-Frank, the enforcement focus on advisers is likely to continue to dominate the docket.” The Corporate & Securities Law Advisor “Securities Enforcement January 2014

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Tough Talk

Chairman White has pledged to make enforcement “bold and unrelenting” under her watch. She has stated “even the smallest infractions” will be pursued and said the SEC “must be aggressive and creative” and “should never shrink from bringing the tough cases, nor fail to bring smaller ones.” Testimony before the United States Senate March 12, 2013 and Remarks at the Securities Enforcement Forum October 9, 2013

Ceresney last year stated that the SEC has no intention of unflexing its muscles, saying there is still “room for bolder action” by SEC enforcers, and “my goal is to help bring the SEC’s swagger back”. Remarks at the Securities Enforcement Forum October 9, 2013

The New Sheriff

The Enforcer

SEC Chair Mary Jo White

SEC Director of Enforcement Andrew Ceresney

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And Asset Managers are a Target

Chairman White has specifically stated that an area of focus will be “to continue to direct our attention to protecting investors from misconduct by investment advisers and mutual funds”. September 26, 2013 speech “Deploying the Full Enforcement Arsenal” ww.sec.gov/News/Speech/Detail/Speech/1370539841202

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It Can Happen Even to the Best

• No Company is immune from an SEC investigation. • Even the best-run company can be subject to negative

press, a disgruntled employee, an investor/client complaint, or disingenuous claims by a competitor.

• Any of these events and many others can cause the SEC to begin an investigation.

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SEC Changes Streamlined Investigative Powers • Relaxed rules on initiating formal orders of investigation. Staff can now

issue subpoenas more easily and quickly. Final Rule: Delegation of Authority to Director of Division of Division of Enforcement August 5, 2009 www.sec.gov/rules/final/2009/34-60448.pdf

New Organizational Structure and Staffing Changes • Enforcement Division was restructured to better focus on significant cases

that will have a meaningful impact. Creation of five new specialized units to focus on the key areas, including a new unit for Asset Management.

• To stay on the cutting edge of industry trends, the units have been hiring industry experts. Hiring new staff with diverse skill sets to expand knowledge base and improve ability to assess risk, conduct examinations, detect and investigate wrongdoing, and focus priorities.

Cooperation and Collaboration • The SEC has touted and demonstrated increased cooperation between

units and divisions of the SEC and between the SEC and other agencies, including foreign regulatory bodies, and law enforcement.

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SEC Changes Enhanced Analytical Capabilities • The Enforcement Division significantly improved its analytical capabilities,

including its capabilities for forensics analysis and for reviewing and analyzing high volumes of electronic documents. OCIE Compliance Outreach Program September 13, 2013 www.sec.gov/info/cco/cco-2013-09-13-presentation-recent-developments.pdf

• The Division of Investment Management created its Risk and Examinations Office, a multidisciplinary office formed to conduct rigorous quantitative and qualitative financial analysis on the investment management industry.

More Data and Increased Access • New data on private funds obtained from the new Form PF filings required

under Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), is used by the SEC to aid examinations and investigations, and risk identification. SEC presentation September 13, 2013 CCO Outreach www.sec.gov/info/cco/cco-2013-09-13-presentation-form-pf.pdf

• Dodd-Frank registration of private equity and hedge funds increased the universe of registered advisers under the SEC scope.

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SEC Initiatives Focused on Asset Managers Aberrational

Performance Initiative

• Announced 2011 • Initiative to combat

fraud by identifying abnormal investment performance, using proprietary risk analytics.

• Focuses on funds that consistently and materially outperform, or funds whose performance is inconsistent with strategy and benchmarks.

Presence Exams Initiative

• Announced 2012 • Focused, risk-based

examinations of investment advisers to private funds that recently registered with the SEC

• Two year initiative with three primary phases:engagement; examination; and reporting.

Never-Before Examined Initiative

• Announced 2014 • Plans to make

examining the estimated 4,000 adviser who have never been visited a priority in 2014.

www.sec.gov/News/PressRelease/Detail/PressRelease/1370540814042

www.sec.gov/News/PressRelease/Detail/PressRelease/1365171485332

www.sec.gov/about/offices/ocie/letter-presence-exams.pdf

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New Policy on Admissions

• In June 2013, the SEC Chair announced a new policy, that in the most egregious cases, the SEC would demand an admission of wrongdoing as a condition of settlement.

• Admissions now required in “certain cases where heightened accountability or acceptance of responsibility…may be appropriate” http://www.sec.gov/news/digest/2013/dig121713.htm

• “Neither admit nor deny” no longer permitted where there is a criminal enforcement action

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And Focus on Individual Accountability

"I want to be sure we are looking first at the individual conduct and working out to the entity, rather than starting with the entity as a whole and working in," White said. "It is a subtle shift, but one that could bring more individuals into enforcement cases.“ SEC Chair Mary Jo White, speech to the Council of Institutional Investors, September 2013

Tougher Settlement

Policy

Individual Accountability

Lengthier and more costly legal battles

Individuals less likely to settle.

Parties incentivized to take chances at trial

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The New Era of the Whistleblower

• Whistleblower Program established under Dodd-Frank. • Pays bounties that reward whistleblowers for tips that lead to

successful enforcement actions. • The goal of the whistleblower program: “getting high-quality,

original information about securities violations directly into the hands of Commission staff” Sean McKessy Chief, Office of the Whistleblower

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SEC Office of Whistleblower Gaining Steam

• In 2013, tips increased of 8% over prior year • Largest Bounty so far = $14M

With the growing visibility of whistleblower rewards, expect continued high volume of tips.

These tips provide new and growing source of information for regulators.

Year FY2011 FY2012 FY2013 Tips 334 3,001 3,238 Source: http://www.sec.gov/about/offices/owb/annual-report-2013.pdf

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And the SEC isn’t the Only Concern

With overlapping regulatory oversight, asset managers may face dealing with and responding to multiple regulators concurrently on the same matter, which drives increased costs.

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Regulatory Is Not All The regulatory problem is big, but in addition to the regulatory claims, other exposures include:

Systemic Risk

Increased Investor Demands

Third Party Exposures

Operational Risk

Increased Loss Costs

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Systemic Risk • Asset managers, like all of the financial services industry,

have been hit by multiple systemic events over the past decade.

• Today’s transformed financial world of globalization, correlation, complex links and interdependencies, appears to present a “new normal” where asset managers will continue to be challenged by the impact of the frequency and breadth of systemic risks.

• Increasingly companies have growing concerns about systemic exposures, arising out of economic, geopolitical, market, or industry events.

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Source: Harvard Law School Forum on Corporate Governance and Financial Regulation: Credit Crisis Litigation Update: It is Settlement Time, Noam Noked, Nov 30, 2013.

Systemic Events Often Implicate Multiple Insurance Products

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• Underwriters cannot effectively “risk select” to

avoid systemic exposure • Systemic loss loads must be funded in order for

insurance products to remain sustainable

Systemic Risk and Insurance

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Investor Demands and Expectations

Increased Investor

Expectations & Demands

Increased Risk of Investor Litigation

Arising out of the financial crisis, asset managers face increased demands and expectations from investors, fund shareholders and clients.

Fee pressures Transparency Valuation procedures and oversight Fund governance Conflicts of interest Risk management practices Third party due diligence and oversight Risk disclosures

Breach of fiduciary duty Breach of contract Failure to disclose risk Improper valuation procedures Excessive fees Failure to follow investment guidelines Failure to perform due diligence Oversight failure

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Investor Demands and Expectations

“Seventy-one percent of investors and operational due diligence analysts surveyed felt that directors should be held personally liable if a fund failed for operational reasons.” Corgentum Consulting Survey March 2014

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With the growing interconnectedness of the financial services industry and increased use of outsourced services, there is increased risk that an error or wrongful act, or the bankruptcy, fraud, or other failure by a service provider, counterparty, strategic partner, or third party manager could trigger litigation. Asset managers are increasingly involved in defending themselves in litigation where the root cause was an error, negligence, fraud, financial failure, or breach by a third party.

Third Party Exposures

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Operational Risk

The risk of loss resulting from inadequate or failed internal processes, people, systems or from external events.

Operational risks that can trigger a claim: • Coding or systems errors • Processing errors • Documentation errors • Mishandling of requests • Failures to follow investment guidelines • Unintentional misrepresentations or misstatements

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Increased Loss Costs

Overall costs for both regulatory investigations and traditional lawsuits have grown dramatically in recent years.

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Increased Loss Costs Crushing Costs of E-discovery E-discovery has become a major cost factor in litigation, and there has been a dramatic increase in e-discovery costs. • The enormous quantities of electronically stored

information make e-discovery a costly process. 90% of data in existence today was created in the last two years and more than 90% of corporate information is in digital format. huronconsultinggroup.com

• The current system of civil discovery encourages parties to bury each other in onerous requests for more and more data.

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Increased Loss Costs Technical and Legal Complexities • Cross jurisdiction or borders. Cases involve multiple law firms to

navigate the complexities of various regulatory, legal and judiciary systems.

• Conflicts of interest and multiple law firms. Matters involving asset managers have a high propensity to have conflict of interest concerns between entities and/or individuals, particularly between a fund directors and the adviser or the fund and the fund manager. These cases often justify separate legal representation for each party.

• Costly legal specialization. Asset management and fund litigation is highly specialized. There are few law firms with the relevant expertise and experience and tend to be at the highest end of the rate scale.

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Conclusion • Asset managers face increasing risk

of regulatory claims and the costs are steep and are incurred rapidly.

• The frequency and breadth of systemic risks is greater than ever before.

• Increased demands and expectations by investors puts asset managers at risk of complaints or legal demands.

• Operational risk and third party exposures that relate to harm to your client, is an ever present litigation risk.

• Legal costs are rising, driven by the scope and challenges of e-discovery.

Insurance Risk

Increased Regulatory Scrutiny

Third party exposures

Operational Risk

Investor Demands &

Expectations

Increased Loss Costs

Systemic Risk

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THANK YOU

Chubb Group of Insurance Companies (“Chubb”) is the marketing name used to refer to the insurance subsidiaries of The Chubb Corporation. For a list of these subsidiaries, please visit our website at www.chubb.com. Actual coverage is subject to the language of the policies as issued. Chubb, Box 1615, Warren, NJ 07061-1615. This document is advisory in nature. The information provided should not be relied on as legal or insurance advice or a definitive statement of the law in any jurisdiction. For such advice, an applicant, insured, listener or reader should consult their own legal counsel or insurance consultant. No liability is assumed by reason of the information this document contains